The philosophical and ethical quandary over the direction of microfinance is an interesting one that gets a lot of play here at Develop Economies. A drive for financial sustainability and the prospect of making profitable investments in microfinance institutions has brought investors to the industry. This development opens up a whole new source of endless capital, but brings with it a new set of conditions that were never there before. For example, a number of private equity firms have begun taking ownership of MFIs, buying equity in the business in exchange for with the expectation of a return. Depending on the mission, these investment funds expect 15-20% return on equity, at the lowest. These are the funds with an explicit social mission. Others may expect even more.
In contrast, the average return on equity for the 1,300 MFIs tracked by the Microfinance Exchange, an industry support organization, is 9.5%. Granted, most of these are small-time operations, many of which are subsidized and are not financially sustainable. The largest and most efficiently-run MFIs – ASA, SKS, and Share in India, BancoSol in Bolivia, Compartamos in Mexico, BRAC in Bangladesh, and others around the world – bring in much more than 15% ROE. So most will not make the cut, unless they make concessions to their business and take a different approach to serving the poor. Perhaps serve fewer of the poorest of the poor, perhaps move upmarket and take on non-poor clientele. You can see signs of this in the numbers. The size of the portfolio begins growing faster than the outreach (the number of borrowers) as the MFI starts serving comparatively wealthier clients that can handle higher loan amounts. These loans are have a higher income and are less costly to service, increasing revenue and lowering operations costs. The tradeoff? The clients aren’t the poorest and are not necessarily the target clients of the microfinance institution.
As organizations focus on profitability and financial sustainability, they begin to take measures that undermine their mission and vision. They begin to forget why they came to exist in the first place. In a quest for profit, they stray further and further from their roots, until eventually they become indistinguishable from a commercial bank. This ghastly transformation is called “mission drift.”
Staying for Tea, another development blog with a practitioner’s perspective and the first non-robot/spammer to post a response on Develop Economies, offers a very thorough overview of the tradeoffs – some might say deals with the devil – made by MFIs in their quest for financial sustainability. He highlights the various shifts undertaken by some MFIs in order to boost their ROE in order to either access the capital markets or become more attractive for investors. A shift from rural to urban, from poor to the vulnerable non-poor, from group loans to individual loans, from starting businesses to growing businesses, are all harbingers of mission drift. And his conclusion:
And now we see the end game. Microfinance is becoming at once more complex as MFIs develop new products like microinsurance and remittance mechanisms, and more simple as many have become more comfortable and unabashed about their profit motives. While more and more impact studies conclude without rejecting the null hypothesis on the new breed of microfinance programs, their investors and founders are raking in huge profits.
While investors pat themselves on the back, stuff their pockets with cash, and cynically declare that they’re just “doing well by doing good”, I wonder how their clients feel. After all, it is the interest charged to the poor that generate profits in the first place. It would be one thing if this new kind of MFI could prove they are helping the poor, but there are almost no studies these days that provide such evidence. So it is on the backs of the poor that these MFIs derive their profit. The industry has done more than lose its first love, it has turned on them and devoured them.
There are a lot of people who agree with Staying for Tea, and there are a lot of people who don’t. I find myself somewhere in the middle. I understand the danger of getting in bed with bottomline-focused investors, but still think microfinance’s movement into the financial mainstream is a good thing. In this journal, I have been somewhat explicit about where I stand in unambiguously-titled posts like “How Profit Supports the Microfinance Social Mission.” In fact, I discovered Staying for Tea’s post, “Profits and Perverse Incentives: The New Face of Microfinance,” after he posted a comment disagreeing with my take on the issue in the post “Yunus on Microfinance: Commercialization is Code Word.” Here is part of his comment:
Yunus’ focus on the profit motive is well placed. When profit replaced poverty alleviation as the key indicator of success, it led MFIs down a path of changes that has left the “industry” with a real identity crisis and left the poorest of the poor again without reasonably-priced access to capital.
Microfinance now looks ever more like a niche in the for-profit banking industry and less like the pro-poor social innovation it began as. Perhaps the old adage of social enterprise “doing well by doing good” needs updating: “getting filthy rich by doing good…maybe” When microfinance practitioners bought into the hubris that every poor person needs a loan, they stepped onto a dangerous path. The only way to fund such a massive scale-up was to access to capital markets. So, microfinance, the miracle of social innovation that solved the incentives problems that made the poor unbankable, shifted its attention to the incentives of investors, and profit replaced poverty alleviation as the critical success indicator.
I agree with some of these points in theory, but I think there is a bit too much hyperbole here, which is the case in both sides of the argument. First, with the exception of SKS in India and Compartamos in Mexico and a few others, very few institutions or people are getting “filthy rich” from microfinance. Second, I am not sure why “industry” is in quotes. Microfinance is an industry, regardless of whether it is for-profit or not-for-profit. And third, no one is forcing people to take loans. The idea that microfinance institutions are like Countrywide Mortgage, giving a home loan to anyone that can move their wrist in a signature-writing motion, belies the fact that clients join up and drop out and decide to take loans or not take loans independently.
This is not to say I disagree with all points. Some investors will fundamentally alter the social mission in pursuit of profit. They will take equity in an MFI and force it to expand and take on less poor clients in order to make a return. This is a bad thing. But profitability in itself is not a bad thing, despite arguments to the contrary. It is the cost of profit in terms of social performance – the commitment to serving the poor – that will determine whether the tradeoff is worth the reward.
This is an issue I have written about extensively. If you are interesting in reading more, see my past articles below:
Thanks to Staying for Tea for posting the comment.